- There have, of course, been and will continue to be many international fi nancial crises: CM Reinhart and KS Rogoff, This Time is Different: Eight Centuries of Financial Folly (Princeton University Press, 2009). This article uses the phrase “global fi nancial crisis” to refer to the crisis caused by asset bubbles and fi nancial system leverage which initially manifested itself in extreme liquidity pressures for fi nancial institutions in mid-2007 and led to massive recapitalisation of fi nancial institutions in the autumn of 2008 and early 2009. It leaves open the question whether this crisis is at an end and, in particular, the extent to which it is one and the same as, or a separate crisis from, the sovereign debt and banking sector troubles now raging in Europe and elsewhere.
- In its Interim Report for the six months ended 30 June 2007, Northern Rock plc reported unaudited consolidated assets as at that date of £113.5bn. As at the same date, the Royal Bank of Scotland Group plc reported unaudited consolidated assets of £1,743bn.
- The Banking (Special Provisions) Act 2008. This has now been replaced by the Banking Act 2009.
- Basel Committee on Banking Supervision, “Report and Recommendations of the Cross-Border Bank Resolution Group” (2010), available at <www.bis.org/publ/bcbs169.pdf>.
- Independent Commission on Banking, “Final Report: Recommendations” (September 2011), available at <www.ecgi.org/documents/icb_final_report_12sep2011.pdf>.
- HM Treasury and Department for Business, Innovation & Skills, “The Government Response to the Independent Commission on Banking” (December 2011), available at <http://cdn.hm-treasury.gov.uk/govt_response_to_icb_191211.pdf>.
- Cannes Summit Final Declaration (4 November 2011), para 28, available at <www.g20mexico.org/images/stories/docs/eng/cannes.pdf>.
- FSB, “Policy Measures to Address Systemically Important Financial Institutions” (4 November 2011), available at <www.financialstabilityboard.org/publications/r_111104bb.pdf>.
- FSB, “Key Attributes of Effective Resolution Regimes for Financial Institutions” (October 2011), available at <www.financialstabilityboard.org/publications/r_111104cc.pdf>; Basel Committee on Banking Supervision, “Global Systemically Important Banks: Assessment Methodology and the Additional Loss Absorbency Requirement” (November 2011), available at <www.bis.org/publ/bcbs207.pdf>; FSB, “Intensity and Effectiveness of SIFI Supervision” (October 2011), available at <www.financialstabilityboard.org/publications/r_101101.pdf>.
- FSB Consultative Document, “Effective Resolution of Sys-temically Important Financial Institutions: Recommendations and Timelines” (19 July 2011), available at <www.financialsta-bilityboard.org/publications/r_110719.pdf>.
- Note 4.
- P Calello and W Ervin, “From Bail-out to Bail-in”, The Economist 28 January 2010, available at <www.economist.com/node/15392186?story_id=15392186>. Earlier proponents of a similar concept include MJ Flannery, “No Pain, No Gain? Effecting Market Discipline via ‘Reverse Convertible Debentures’” in HS Scott (ed), Capital Adequacy Beyond Basel: Banking, Securities and Insurance (Oxford University Press, 2005).
- At an EU level, the prospects are somewhat better. The EU Commission has proposed a framework involving co-ordination of national resolution planning and powers, including power to bail-in debt and stay temporarily the exercise of termination rights. However, this framework would also fall short of binding ex ante commitments, including on burden-sharing. Commission Communication, “An EU Framework for Crisis Management in the Financial Sector” COM(2010) 579 fi nal, available at <http://ec.europa.eu/internal_market/bank/docs/crisis-management/framework/com2010_579_en.pdf>; DG Markt Working Document, “Technical Details of a Possible EU Framework for Bank Recovery and Resolution”, available at <http://ec.europa.eu/internal_market/consultations/docs/2011/crisis_management/consultation_paper_en.pdf>.
- Proposed comprehensive solutions include: using choice-of-law provisions to specify which jurisdiction's laws will apply in insolvency, either in individual contracts or by a provision in the charter of the fi nancial institution concerned (R Rasmus-sen, “A New Approach to Transnational Insolvency” (1998) 1 Michigan Journal of International Law 19; PK Wallinson, “Debtor Selection: Resolving Insolvent, Globally Active Financial Firms”, Financial Services Outlook, American Enterprise Institute for Public Policy Research (March 2010)); structuring SIFIs as a single entity, subject to home country resolution (C Cumming and RA Eisenbeis, “Resolving Troubled Systemi-cally Important Cross-Border Financial Institutions: Is a New Corporate Organisational Form Required?” Federal Reserve Bank of New York Staff Report No 457 (July 2010)); extending to banks the UNCITRAL Model Law on Cross- Border Insolvency, with its provisions for the recognition of and grant of assistance to the main proceeding; creating a new model law for cross-border insolvency of cross-border fi nancial institutions; and negotiating bilateral or multilateral treaties containing ex ante commitments regarding recognition of measures and burden-sharing.
- International Monetary Fund, “Resolution of Cross-Border Banks – A Proposed Framework for Enhanced Coordination” (11 June 2010), available at <www.imf.org/external/np/pp/eng/2010/061110.pdf>.
- Key Attributes, Foreword, p 1.
- Ibid, para 1.1.
- However, this recommendation is not applicable to branches in Europe to the extent that the Credit Institutions Winding-up Directive 2001/24/EC (the Winding-up Directive) confers universal resolution authority on the home state.
- Key Attributes, para 2.3(iv).
- Ibid, para 3.9.
- Ibid, para 5.1.
- The FSB does not seek to defi ne how “no creditor worse off than in liquidation” should operate. A key question is whether the (hypothetical) liquidation against which the creditor's position is compared is a liquidation of the fi rm without the benefi t of any public support, even if such support has in fact already been given at the point of resolution; in practice, the resolution of a large fi rm may involve such support, including through the use of lender of last resort facilities. S 57(4) of the UK Banking Act 2009 addresses this issue by providing that the valuation of the fi rm against which compensation should be assessed should ignore actual or potential fi nancial assistance provided by the Bank of England or the Treasury (disregarding ordinary market assistance provided by the Bank of England on its usual terms).
- Key Attributes, para 10.5.
- See Basel Committee on Banking Supervision, “Resolution Policies and Frameworks – Progress So Far” (July 2011), available at <www.bis.org/publ/bcbs200.pdf>. See also the national responses to a survey by the FSB Implementation Monitoring Network, commenting on the state of development of resolution tools in 2010, published by the FSB on 12 November 2010 and available at <www.financialstabilityboard.org/publications/r_101111b.htm>. For some of the gaps and differences in EU resolution regimes, see GGH Garcia, RM Lastra and MJ Nieto, “Bankruptcy and Reorganisation Procedures for Cross-Border Banks in the EU: Towards an Integrated Approach to Reform of the EU Safety Net”, LSE Financial Markets Group Paper Series, Special Paper 186 (May 2009).
- For example, the special resolution regime under the Banking Act 2009 does not extend to signifi cant non-regulated operational entities or to branches of foreign fi rms; the special resolution objectives (s 4) are limited to UK fi nancial stability; the regime does not extend to G-SIFIs other than deposit-taking institutions; the mechanisms for implementing bail-in are limited in extent; there is no stay on termination rights; and there is no provision for the recognition of foreign resolution measures.
- On the basis of the Detailed Tables on Preliminary Locational and Consolidated Banking Statistics at end-June 2011 published by the Bank for International Settlements in October 2011 (available at <www.bis.org/statistics/provbstats.pdf#page=74>) the top ten such jurisdictions (in descending order of importance in terms of location of immediate borrower) as at that date were the USA, the Hong Kong SAR, France, Germany, Ireland, China, the Netherlands, Japan, Spain and Australia.
- Arts 37f and 37g of the Swiss Bankengesetz, which encourage coordination and empower the Swiss regulator (FINMA) to grant recognition to foreign measures, are one exception to the general rule that domestic resolution powers ignore cross-border co-operation issues. Ss 210(a)(1)(N) and 210(k) of the US Wall Street Reform and Consumer Protection Act (Dodd– Frank Act) also contain provisions empowering co-ordination with foreign fi nancial authorities, but only in relation to “covered fi nancial companies” within the meaning of that Act.
- National depositor preference was introduced in the USA by the Omnibus Budget Reconciliation Act of 1993, which amended s 11(d)(11) of the Federal Deposit Insurance Act. It applies to “deposit liabilities” of a US depository institution that are payable at any offi ce located in the USA, the District of Columbia or any territory of the USA. See JA Marino and RL Bennett, “The Consequences of National Depositor Preference”, FDIC Banking Review (October 1999), available at <www.fdic.gov/bank/analytical/banking/1999oct/2_v12n2.pdf>.
- Key Attributes, para 11.8.
- Ibid, para 7.2.
- Ibid, para 7.5.
- The problems of cross-border co-operation are well explored by S Claessens, R Herring and D Schoenmaker, “A Safer World Financial System: Improving the Resolution of Systemic Institutions”, Geneva Reports on the World Economy (July 2010). For a game theory view of the prospects of co-operation at an EU level, see V Gaspar and G Schinasi, “Financial Stability and Policy Cooperation“, Banco de Portugal Occasional Papers 1 (2010), available at <www.bportugal.pt/en-US/BdP%20Pub-lications%20Research/op201001.pdf>. See also E Avgouleas, C Goodhart and D Schoenmaker, “Living Wills as a Catalyst for Action”, Duisenberg School of Finance Policy Paper no 4 (February 2010), for a discussion whether recovery and resolution plans will provide the opportunity to reach ex ante agreement on burden-sharing.
- TF Huertas, “The Road to Better Resolution: From Bail Out to Bail In”, Special Paper 195, LSE Financial Markets Group Paper Series (December 2010), 12.
- The Form 10-Q of Washington Mutual Inc for the period ended 30 June 2008 reported total consolidated assets as at that date of US$309.7bn.
- The fi nancial statements of JP Morgan Chase & Co for the third quarter of 2011 show total consolidated assets as at 30 September 2011 of US$2,289bn.
- Key Attributes, para 11.4.
- The liquidity coverage ratio (and to a lesser extent the net stable funding ratio) would indirectly address collateralisation in requiring a certain funding structure and the availability of liquid securities that can be used as collateral. However, at the point when a fi rm undergoes bail-in, it is likely to have burned through the collateral required by the liquidity coverage ratio.
- For example, in the USA the Dodd–Frank Act has placed sig-nifi cant obstacles in the way of the provision of offi cial sector funding to a troubled institution, either through “open bank assistance” from the Federal Deposit Insurance Corporation or through loans from the Federal Reserve System (under s 13(3) of the Federal Reserve Act).
- In terms of domestic banking assets as a percentage of gross domestic product, consolidated by nationality of headquarters, the UK is more exposed that any major country: see the Government Response, Chart 1.A, p 11.
- For a discussion of the way in which Switzerland has addressed its own “dilemma”, see HC von der Crone and L Beeler, “Regelung Systemrelevanter Banken aus wirtschaftsrechtlicher Sicht – Lösungsansätze zur Too-Big-To-Fail Problematik in der Schweiz” (2011) I(2) ZSR 130.
- For a fuller summary and discussion of the ICB's proposals, including on competition in retail banking, see Slaughter and May, “Resolving the Dilemma of British Banking: the Final Report of the Independent Commission on Banking” (September 2011), available at <www.slaughterandmay.com/media/1604103/resolving-the-dilema-of-british-banking.pdf>. This article borrows summaries of the ICB's proposals from this briefi ng.
- Single market rules mean that ring-fencing the UK activities is not possible. The ICB Report envisages that EEA activities may be included within the ring fence but does not mandate that they be included. See ICB Report, para 3.44.
- ICB Report, para. 3.39.
- Ss 23A and 23B of the US Federal Reserve Act provide some precedent for this.
- For non-UK headquartered G-SIFIs, only the UK ring-fenced subsidiaries would have to meet the primary loss-absorbing capacity requirement. Of course, no such requirement could be imposed on EEA fi rms operating in the UK under the passport regime.
- It is to be hoped that the UK government will take the opportunity provided by implementation of the ICB's report to consider other adjustments to the creditor hierarchy that currently applies in the liquidation of banks and, if necessary, extend the defi nition of liabilities that can be written off on resolution. The clearest candidate for this reconsideration is provided by the claims of current and former shareholders: at present, shareholder claims against the fi nancial institution, such as disclosure-related claims, may rank pari passu with other unsecured debt (Soden v British & Commonwealth Holdings plc [1998] AC 298, fi nding that such claims were not a “sum due to any member of the company (in his character of a member)” within the meaning of s 74(2)(f) of the Insolvency Act 1986; see also s 655 of the Companies Act 2006). This has the absurd result that the parties who bail out or bail in a systemically important fi nancial institution fi nd that the shareholders or former shareholders are able to assert claims (such as disclosure-related claims) that will be afforded prior ranking, undermining the loss absorbency of equity capital and perpetuating moral hazard. The Davies Review of Issuer Liability (HMSO 2007) concluded that the issue of subordination of investor claims needed further work, but it is suggested that where “too big to fail” considerations are concerned this issue should be addressed without delay.
- See note 6.
- Government Response, Box 2.B, page 35.
- Ibid, para 2.52.
- Ibid, paras 2.64 and 2.65.
- Ibid, paras 2.68–2.72.
- Ibid, para 3.22 and 3.23.
- Ibid, paras 3.31–3.38.
- Ibid, para 3.32.
- Ibid, para 3.51.
- A McKinsey study found that, in a sample of 115 large global banks, the ratio of tangible common equity (TCE) to RWAs was the best predictor of fi nancial failure during the 2007–09 period and that no fi rms with a TCE/RWA ratio of more than 10% failed during this period: K Buehler, H Samandar and C Mazingo, “Capital Ratios and Financial Distress: Lessons from the Crisis”, Working Paper no 15 (McKinsey December 2009).
- Government Response, Box 3.B, p 41.
- ICB Report, para 4.122.
- Box 5.B on pp 65 and 66 of the Government Response discusses how resolution might operate in the case of a ring-fenced bank. Although this will only be the case where the legal entity concerned is a credit institution. Of course, much will depend on how the UK/EEA ring-fence is drawn: to the extent that it includes assets governed by the law of countries outside the EEA, recognition of UK reorganisation measures under the Winding-up Directive will not be available.
- Although the government notes that the existing Special Resolution Regime under the Banking Act 2009 contains powers to impose losses on creditors in some circumstances: Government Response, para 3.37.
- Clifford Chance, “Legal Aspects of Bank Bail-ins” (May 2011).
- Lord Turner makes this point in the lecture referred to in n 70 infra.
- ICB Report, para 3.28.
- ICB, “Issues Paper: Call for Evidence” (September 2010), para 3.16.
- Where the Winding-up Directive applies, as will be the case with most of the UK operations of Deutsche Bank, the UK authorities will in any event be required to defer to reorganisation measures or winding-up proceedings in the home Member State.
- Nor indeed UK-owned investment banking businesses unless the group is also engaged in retail banking.
- See, for example, S Aiyar, “How Did the Crisis in International Funding Markets Affect Bank Lending? Balance Sheet Evidence from the United Kingdom”, Bank of England Working Paper no 424 (April 2011).
- ICB Report, para 4.36.
- A Turner, “Leverage, Maturity Transformation and Financial Stability: Challenges Beyond Basel III”, lecture at Cass Business School (16 March 2011), available at <www.fsa.gov.uk/pubs/speeches/031611_at.pdf>.
Law and Financial Markets Review
Volume 6, 2012 - Issue 1